Merkel: Only a unified Europe can remain powerful

DAVOS, Switzerland — German Chancellor Angela Merkel insisted Wednesday that Europe will remain an economic power only if it deepens the integration that has caused it so many problems. Without that, she warned the global elite gathered in a Swiss ski resort, Europe will remain little more than a pleasant vacation destination.

The tone of Merkel's keynote address was not dramatically different from her measured norm, but it was positive enough to feed an emerging feeling among European power brokers that Germany — and hence Europe — is finally becoming convinced that it needs to do whatever it takes to save the euro from collapse.

"The message is that we are ready for more commitment. We are no longer making excuses," Merkel said. If Europe doesn't integrate further, she said, "we will remain an interesting holiday destination for a long time, but we won't be able to produce prosperity for the people in Europe anymore."

Merkel pledged to do what is necessary to protect the euro from collapse, and said greater European unity is needed to spark job creation and growth. However, she poured cold water on calls for Europe to ratchet up the financial firepower of its safety net for failing economies.

Germany is at the center of any rescue plan because it has the deepest pockets in Europe. And Europe is at the center of the global outlook because many fear a collapse of the euro could drag large parts of the world back into recession.

For months, Germany has argued that indebted countries much cut their budgets to the bone, and that their people must become poorer, in exchange for help in reducing their debt loads. But many say that will do little good if that very austerity causes growth to evaporate, making countries unable to pay back the debt that remains.

George Soros, the philanthropist and former financier, called Germany a task master imposing a strict anti-inflationary viewpoint on the rest of the continent. He said weaker eurozone countries have been "relegated to the status of third world countries" having to pay back debts in a foreign currency.

"The problem is that the austerity that Germany wants will push Europe into a deflationary death spiral. ... The economy will contract and tax revenues will fall. So the debt burden ... will actually rise, requiring further budget cuts and setting in motion a vicious cycle."

Merkel's government has been unwilling to back two proposals voiced as potential solutions to the 2-year-old debt crisis: "eurobonds" backed jointly by all eurozone countries, and stimulus that essentially involves getting the European Central Bank to print more money.

In the past month, business leaders and academics say they have become increasingly confident that Germany — once its back is against the wall — will go along with measures to boost growth, and possibly save Europe from deeper crisis.

"We are starting to see signs of a shift in sentiment towards Europe," said Baudouin Prot, CEO of French bank BNP Paribas.

He said the catalyst for the newfound optimism was a round of reasonably priced long-term loans to European banks by the European Central Bank, which caused spiking interest rates for European bonds — a key indicator of confidence in their ability to pay back the money — to drop.

"We are on the right track, but we need to keep moving forward. We need each country to implement financial discipline," Prot said. "But it's not just about debt reduction. Europe also needs a growth strategy, a series of initiatives to open up the market, support innovation and competitiveness."

He said all 17 countries that use the euro must improve their finances, and that Europe as a whole needs to act better as a whole. He also cautioned against overregulation of banks.

Soros had a gloomier outlook but said he too sees Germany coming around to the idea that austerity is not enough, and that too much of it will just end up making matters worse.

"The argument is really very strong and I believe that it has to eventually sink in," he said.

Soros and others stressed that tough decisions need to be taken and that Europe is far from out of the water. What is changing is that leaders increasingly believe that Europe — its back against the wall — is finally acting. In December, the leaders of the 17 countries that use the euro agreed they need new rules that they're now working out, calming markets.

"Europe is focusing on the wrong problem," he said. "Clearly debt has to be brought down. But Europe suffers from a lack of growth, not a high level of debt. ... Basically you need to address a debt problem by focusing on growth."

Oxford University professor Timothy Garton Ash said there's still a good chance Greece will default on its debt. What matters, he said, is how Europe responds: If it builds an effective firewall to prevent the crisis from spreading to other countries, that would go a long way to calming the fears that have caused so much turmoil.

"I do think there really is a shift in sentiment and perceptions," Garton Ash said. "The market sees that Germany is really willing to do what it takes."

The fear that gripped markets in the second half of 2011 was largely due to concerns that Italy — the eurozone's third economy — would default on its debt, and that it would be too big for Europe to bail out. A default by Italy would send massive shock waves round the global economy as well as potentially wiping out large chunks of Europe's banking system.

Amid the discussion of Europe's debt woes came a sense that Western-style capitalism, as practiced for decades, is moving into a new phase. A four-year economic crisis is putting pressure on politicians to build a new model.

David Rubenstein, managing director of asset management firm Carlyle Group, said leaders must work fast to overcome the crisis or see other models of capitalism, such as the form practiced in China, win the day.

"We've got to work through these problems. If we don't do that in three or four years ... the game will be over for the type of capitalism that many of us have lived through and thought was the best type," he said.

China has reaped the rewards of its transition to a more market economy and is now the world's second-largest economy. Unlike the capitalist systems in the U.S. and Europe, China's market transformation has been heavily guided by a state apparatus that continues to balk at widespread democratic reforms. Latin America, too, has seen success in the development of "state capitalism" in certain industries.

At the economic forum, there were numerous references to the need to innovate, the need to consult with employees and the realization that power in the world is shifting from the west to the east. While the traditional industrial economies of the United States and Europe have limped through the last few years, often from one crisis to another, many economies in Asia and Latin America have been booming.

Outside the conference center, activists are camped in igloos to protest years of crisis in which hundreds of millions have lost their jobs even as top executives still reap huge pay packets. On Wednesday they sent aloft big red weather balloons carrying a protest banner reading "Hey WEF, Where are the other 6.9999 billion leaders?"